capital is not adjusted to reflect the value of the
researchassetorthecapitalvalueofoperatingleases,
and by the presence of high inflation.- Theoperatingincome,likethebookvalueofcapital,
isanaccountingmeasureoftheearningsmadebya
firm during a period. All the problems in using
unadjustedoperatingincomedescribedinChapter 4
continue to apply. - Even if the operating income and book value of
capitalaremeasuredcorrectly,thereturnoncapital
on existing investments may not be equal to the
marginalreturn oncapital that thefirm expectsto
make on new investments, especially as you go
further into the future.
Giventheseconcerns,youshouldconsidernotonlyafirm’s
currentreturnoncapital,butanytrendsinthisreturnaswell
astheindustryaveragereturnoncapital.Ifthecurrentreturn
oncapitalforafirmissignificantlyhigherthantheindustry
average,theforecastedreturnoncapitalshouldbesetlower
thanthecurrentreturntoreflecttheerosionthatislikelyto
occur as competition responds.
Finally,anyfirmthatearnsareturnoncapitalgreaterthanits
costofcapitalisearninganexcessreturn.Theexcessreturns
aretheresultofafirm’scompetitiveadvantagesorbarriersto
entryintotheindustry.Highexcessreturnslockedinforvery
longperiodsimplythatthisfirmhasapermanentcompetitive
advantage.
ILLUSTRATION 4.7: Measuring the Reinvestment Rate,
ReturnonCapital,andExpectedGrowthRate:TitanCement
and SAP